Friday, December 29, 2006

This summer's oil supply and demand crunch, with its record high prices, helped make Peak Oil a mainstream concern in 2006. I've been following this issue since the 1990s, long before starting this blog. It's easy to get wrapped up in the technical details of theories and projections, and miss the enormous social implications of this phenomenon. I examined that aspect of Peak Oil in this posting from March.

Peak Oil is shaping up as the next Y2K. By that, I'm not just referring to the potential consequences of a peak in global oil production, which some forecasters predict will occur within the next few years. I see the resemblance to Y2K in much broader terms, as a major social phenomenon with dramatic, but highly uncertain outcomes, operating simultaneously on the levels of reality and perception. That makes it even more interesting, but also more problematic.

Consider:

Though hardly as precisely specified as "midnight January 1, 2000," Peak Oil threatens us with an imminent global systemic breakdown. Our food supplies could dry up, workers' jobs vanish, and the world descend into chaos and resource wars. That gets your attention.

As with Y2K, it's possible that if we were to undertake the anticipatory remedies that experts prescribe--in this case massive investments in energy efficiency and alternative energy production--it might be impossible after the fact to ascertain whether Peak Oil would have ever caused the outcomes that have been predicted, and we'll be saddled with second-guessing about whether we should have bothered.

Peak Oil also seems to be spawning a survivalist mentality, demonstrated at least anecdotally by the San Francisco lawyer who has set up a website devoted to this and plans to "drop out" to a remote, self-contained farm.

Peak Oil, like Y2K before it, is becoming a publishing and media goldmine.

The final similarity may be the most sobering. We'll know soon enough whether the pessimists or the optimists are right. It could turn out to be a major upheaval or an embarrassing fizzle. This won't be as black and white as it was for Y2K, but if we get to 2010 without an observable Peak--or unambiguous evidence of one in sight--the window of belief in this phenomenon, which has been around for decades in various forms, will likely close for another generation.

Whatever its scientific foundations, it's clear that Peak Oil feeds the innate human tendency towards millenarianism and catastrophism. There's even some recent thought that those of us who came of age in the 1970s and 1980s may be particularly predisposed to this, having experienced oil shocks, Vietnam, Watergate, the Cold War, the Iran hostage crisis, and dozens of cheesy disaster movies. (The death this week of President Ford has provided a wealth of 1970s flashbacks.)

There's another, potentially positive analogy to Y2K. It's generally accepted that, although Y2K never manifested in its worst form, anywhere, the precautionary investment in upgraded information and communications technology has paid enormous dividends. Premature predictions of an imminent peak in global oil production could be just what's needed to galvanize governments and consumers to begin the decades of preparations that the SAIC report on Peak Oil suggests are necessary to avoid its worst consequences. So while I'm a skeptic, I also see that a bit of Peak Oil hype now might be helpful, unless it sets up a backlash after the next set of milestone dates passes without a Peak.

Energy Outlook will resume new postings on January 2, 2007. I wish you all a Happy New Year!

Thursday, December 28, 2006

I wrote this posting in March, but it remains timely. Many of us expect 2007 to bring a renewed emphasis on energy efficiency, and even bigger incentives for renewable energy. The large-scale deployment of renewables will change our basic relationship with energy in ways we may not expect. The inherent properties of fossil fuels have spoiled us and made it difficult to appreciate the compromises associated with many other energy sources.

Our civilization uses quantities of energy on roughly the same order of magnitude as the entire energy flux generated by the molten core of the earth. That's surprising and even counter-intuitive, but it makes sense if you consider that the fossil fuels that supply 86% of our energy are really--as we've heard so many times--highly concentrated sunlight. When you unpack that cliche, you realize that by consuming in a century or two the results of millions of years of gradual, inefficient-but-cumulatively-monumental energy storage processes, we are able to "live large"--to use energy on a planetary scale without having to collect it concurrently from the sun and the earth.

As a result, we've grown accustomed to sourcing our energy far from where most of us live, in oil fields, gas wells and coal mines all over the world--but typically distant from urban concentrations. The portion of this that we're used to seeing around us is just distribution infrastructure--power lines, gas stations, and the occasional pipeline or refinery. Renewable energy on a large scale will change that situation utterly. We will go from a world of energy-at-a-distance to energy-all-around-us.

Consider wind turbines. A state-of-the-art turbine generates between 3 and 5 Megawatts of electricity, when the wind blows. A natural gas-fired power plant, on the other hand, generates anywhere from 500 to 1000 MW, and can do so around the clock, more than 90% of the year. Replacing this much fossil fuel with wind entails building 800 or so structures, each taller than the Statue of Liberty (ground to torch.) If we wanted to replace all of the fossil fuels used in US power generation, it would require over 300,000 of these installations.

Nor am I singling out wind; do the math for solar, geothermal, wave power, or anything else you like, and you'll see that, to have a material impact at the scale the human race uses energy, we will need lots of them, everywhere. Biofuels? Great stuff, but plan on devoting a lot of land to them. How much? Well, replacing the entire global output of petroleum would require around 5 billion acres, at current yields. This works out to about half of all land currently under cultivation. By comparison, drilling in ANWR and offshore Florida is quite unobtrusive, because those nasty old hydrocarbons are still the most concentrated forms of energy around, other than Uranium.

Now, you might read this as an attempt to make renewable energy look impossible, or at least extremely unattractive. Far from it. It's meant as a reality check. Opting to make renewables a major part of our future energy supply will require setting aside our tender sensibilities and being confronted on a daily basis with the real-world foundation of the energy-consuming pyramid atop which we sit. Unless, of course, the goal is only enough renewable energy to make us feel good, but not enough to matter.

Wednesday, December 27, 2006

Iran was in the news frequently this past week, first for its rejection of the latest UN resolution relating to its nuclear program, and later in a report issued by the National Academy of Sciences, indicating that Iran's oil exports could decline precipitously within a decade. For those looking to connect dots, these two seem quite tempting. However, while the idea that Iran might need nuclear power because its hydrocarbons are running out has the advantage of simplicity, this interpretation strikes me as too superficial. It also ignores the reality that electricity and petroleum fill distinctly different market segments, and are not easily substitutable for each other, given today's technology. If there is a connection, it is a less obvious one.

With Iran continuing to enrich Uranium in spite of IAEA and Security Council admonitions, the UN last week ratcheted up the pressure with another Security Council resolution, this one involving mild sanctions. It remains to be seen whether they are tough enough to cause real pain for President Ahmadinejad and the ruling mullahs, or will serve merely to annoy them. President Ahmadinejad's response, suggesting Iran will increase the pace of its nuclear activities, included what must surely be the first reference to the Muppets in the history of diplomacy. Unless this was a playful mistranslation, it reveals how the regime regards the countries that joined the UK and US in voting for the resolution.

The NAS study on Iran's future oil export potential will not surprise those who have been watching economic trends in Iran, and the degree to which US sanctions and Iran's own policies have impeded large new oil projects. I'm not sure how much light it sheds on the country's motives for developing nuclear power. As I discussed in an article written for Geopolitics of Energy in 2005, nuclear power could indeed displace domestic hydrocarbon consumption and free up additional volumes for export, but the hydrocarbons displaced would be principally natural gas, not oil. Furthermore, nuclear power costs more than the value of the gas it would free up, particularly when many trillions of cubic feet of Iran's gas remain undeveloped. Building a self-sufficient nuclear fuel capability, rather than buying fuel rods on the open market, further inflates the cost of incremental gas exports beyond any realistic LNG market price.

Despite the lack of a plausible direct connection between oil exports and nuclear power, these two issues may still be related. The prospect of losing its status as a top oil exporter must be very troubling to Iran's leaders. Iran's 2.6 million barrels per day of exports currently account for about 7% of global exports. With oil prices over $60/barrel and absent enough global spare capacity to replace their contribution, Iran holds a trump card in any negotiations or confrontation with the US and EU. If the NAS report is correct, that advantage will erode steadily over the next decade. Facing the prospect of losing their oil weapon, it's not hard to fathom that Iran--which sees itself as the rising power in the region--would want another, even more powerful deterrent. Thus the connection between this month's dots could well be the substitution of a new strategic weapon for a fading one, rather than one form of energy for another.

Tuesday, December 26, 2006

Pipelines are among the most prosaic elements of our energy infrastructure. Big, controversial ones crossing national frontiers get a lot of attention, but the rest generally hum along, year after year, unnoticed unless they experience a leak. A new technology offers the possibility of plugging pipeline leaks in much the same way our bodies heal cuts. An article in Technology Review describes how this technique was developed by a Scottish engineer and recently tested by a big oil company under real-world conditions, undersea. What intrigues me the most about this idea, however, is not just the highly beneficial prospect of reducing the environmental damage caused by oil spills from pipelines, but how a fully-developed self-patching technology could reduce the risks associated with future oil development in sensitive areas, and expand our potential supply base.

It would be hard to imagine our present industrialized world without energy pipelines. They make it possible to carry large volumes of petroleum and its products long distances, very inexpensively. Moving the same volumes for comparable distances overland by rail or truck would be immensely more intrusive, hazardous, and expensive, and it probably wouldn't have happened, along with a good deal of the energy use that pipelines have facilitated. That's even more true for natural gas. (You can take that as a benefit or drawback of their development, depending on your viewpoint.)

One of the biggest problems with pipelines is not the risk of a catastrophic rupture, which occur rarely and are immediately evident to operators, but of smaller leaks that can create serious localized environmental damage before being detected, requiring expensive cleanups. Department of Transportation data indicate that, on average, just under 100,000 barrels per year of "hazardous liquids"--mostly oil and its products--has leaked from US pipelines since 2001, the equivalent of an Exxon "Valdez" every three years. Reducing this volume would have very significant benefits for both the industry and the environment, and the artificial platelet technology described in the article is a clever answer to this problem.

Plugging leaks this way could have applications beyond liquid pipelines, as well. Similar technology might be deployed on oil tankers and remote storage tanks, limiting leaks of oil or other dangerous fluids from a variety of sources. If the platelets could be adapted to work in natural gas pipelines, they might even address a significant source of greenhouse gas emissions. Methane emissions from natural gas systems accounted for roughly 2% of all US greenhouse gas emissions last year, according to the Department of Energy.

The value of a fast-acting anti-leak system could be even greater in changing perceptions about the risk of leaks in sensitive areas. Something like this would have to go through a lot of testing and experience in existing installations, before it would be deemed reliable enough to alter the balance of risks associated with developing oil fields in the arctic, for example. Nor would this be universally welcomed, since there are many who oppose such development on general principles, rather than on its actual track record and risks. But as I've suggested before, any serious discussion of energy security must consider expanded oil drilling as a serious option, weighing its environmental impact against that of alternative hydrocarbons, such as coal liquefaction or oil sands extraction. Self-healing pipelines would enhance oil's side of this ledger substantially.

Friday, December 22, 2006

Since moving to Virginia, it often takes me an extra day to catch up on stories from the New York Times, because the Washington Post and Wall Street Journal now both take precedence. But even if I'm tardy on this item, I can't let an article in yesterday's Times on the problems of market-based mechanisms for reducing greenhouse gas emissions escape comment. Emissions trading in its broadest definition, involving the transfer of emissions reductions made by one party to another party needing to reduce, is a key element of the Kyoto Treaty, and of the kind of cap-and-trade system recently enacted in California and contemplated for the entire US. From the start, though, this concept has been controversial. Yesterday's article illustrates several concerns about emissions trading, including the risk of paying for cuts that would be made anyway, the possibility of causing unintended, adverse consequences, and high transaction costs. While these are all serious issues, they do not outweigh the substantial benefits of trading.

The Kyoto Protocol provided two primary mechanism by which emissions reductions made in one country could offset emissions in another: Joint Implementation and the Clean Development Mechanism (CDM.) The Times focuses on the latter, which is intended to foster emissions-reducing investments in developing countries, with credit for the cuts flowing back to the investor and counting against its national emissions target under Kyoto. Should we be concerned that many of the initial projects have apparently focused on a narrow segment of emissions--albeit one with greatly disproportionate impact--in a small number of countries, and at a higher effective cost than the actual cost of the projects? Since all GHG emissions are essentially equivalent, and the ones in question represent classic "low-hanging fruit," they are appropriate early targets and ideal trading opportunities.

As to cost, the proper basis of comparison is not the underlying cost of reducing the emissions in country X, but rather the alternative cost of achieving equivalent cuts in the investor's home country. If a ton of CO2 can be eliminated in China at a price to the investor of $20, when the cost of cutting the investor's own emissions would be $40, it is irrelevant if the Chinese reductions cost only $5 to achieve, with the difference flowing to various middlemen. The net result of this little demonstration of capitalism still reduces twice as many emissions as would be cut for the same expenditure elsewhere, and the entire planet is better off.

Another concern raised by the Times is harder to dismiss. In the case of the Freon plant in China, it appears that the project to reduce its emissions might have the undesirable effect of prolonging or expanding production of a substance that is meant to be phased out under the Montreal Protocol on ozone depletion. This example reflects either a loophole in the system, or the misapplication of the "additionality" standard for CDM under Kyoto by the parties certifying the emissions reductions. I don't see that as an argument against trading per se, but rather as an issue affecting the rules under which trading is conducted, and thus meriting further investigation and discussion.

Readers of the Times might be tempted to conclude from this article that emissions trading is mostly smoke and mirrors, and doesn't advance the cause of reducing greenhouse gas emissions nearly as much as its advocates claim. If that interpretation were to undermine suggestions for implementing such a system in the US, then it would be a costly conclusion, indeed. The alternative to this kind of trading is reducing our emissions the hard way, at every US source. That would take much longer and cost much more, resulting in a faster accumulation of atmospheric greenhouse gases and more rapid climate change. As the market for emissions reductions develops, participants must work to drive out the inefficiencies and close loopholes, to ensure that we get the most emissions reductions bang for the buck. But that is no reason to turn our backs on a tool that will save us billions of dollars, either in up-front costs or in averted climate-change-related damage, later.

Energy Outlook will observe the Christmas holiday next Monday and resume postings on Tuesday. Seasons Greetings to all my readers.

Thursday, December 21, 2006

Yesterday's Wall Street Journal raised the specter of another large wave of consolidation in the oil and gas industry, triggered by this week's announced merger between Norway's Statoil and Norsk Hydro. Unsurprisingly, the Journal focused on the industrial logic of such tie-ups, along with the mismatch between stagnating oil prices and rising earnings expectations. However, at the scale of the top companies, these rationales start to ring hollow, when we examine their potential drawbacks, which increase in scale in proportion to the size of the merged companies. On balance, further mergers among the top tier of companies seem unlikely to deliver lasting value to shareholders, while doubling down bets that are overdue for diversification.

The first drawback is a paradox of sorts. Many of the biggest mergers have been driven by the need for the major oil companies to continue growing reserves, to replace those consumed in production and to grow, overall. Finding oil on Wall St., rather than with the drill-bit has been a good way to shift reserves from weaker to stronger players--paralleled by the inevitable recycling of the least desirable acquired properties to smaller, lower-cost operators--but it generates its own limits. Having rolled up a long succession of companies, including Sohio, Amoco and Arco, BP's annual oil and gas production now stands just under 1.5 billion barrels of oil equivalent (BOE.) That means that in order to keep its reserves replenished, it must find the equivalent of a Thunder Horse field--or buy a company the size of the former Unocal every year. Revisions and extensions on existing reserves cannot handle that load forever. The bigger you are, the harder this gets. The Journal provided a nice illustration of this phenomenon by suggesting that Hess, valued at $14 billion, wasn't big enough to interest the Super-majors.

Another counter-argument is harder to quantify, relating to how big mergers are typically executed in the oil patch. The corporate headquarters usually doesn't change much, because axing the acquired company's headquarters staff and top management provides easy synergies. But the legacy folks attached to the acquired assets are still out there, and they will reflect their origins for years. Corporate cultures don't mix like martinis; they mix like yogurt with the fruit on the bottom. Could this phenomenon have contributed to the problems at BP's (formerly Amoco's) Texas City refinery? It's hard to say, but if you keep gobbling up new companies before you've fully digested your previous meals, it could matter a lot.

If second-tier companies feel the need to merge, in order to compete with the Supers, I can't argue with that. But I would suggest that for the largest players, the time has come to cast their sights in a direction that doesn't require running faster and faster on the reserves treadmill, and where the inevitable culture clashes would infuse truly divergent, stimulating viewpoints. That means branching out into energy segments that are either less mature, or that don't have this same reserve-replacement characteristic. When you consider the big external challenges of energy security and climate change, two logical choices emerge: investing in alternative energy, including biofuels and unconventional hydrocarbons, or electricity, which seems likely to start eroding oil's transportation market share within ten years.

There are good reasons in classical economics and current business practices for managers to conclude that there are significant returns to scale in this industry. At the same time, however, this is subject to diminishing returns at some point, perhaps around the current size of the Super-majors. When you're as big as Shell or ConocoPhillips, is there really any project you can't take on, any technology or region you can't afford to participate in? But when a CEO has built a personal reputation--and the firm's market capitalization--on successful mergers, how can he tell shareholders it's time to learn a new trick? That seems like the essence of good leadership.

Wednesday, December 20, 2006

It has taken me much longer than I expected to see Al Gore's film on climate change, "An Inconvenient Truth," mostly as a consequence of my move from Connecticut to Virginia not long after its release. The documentary is out on DVD, now, removing all my remaining excuses and making it as painless as a click on a Netflix menu. I am glad that I've seen it, not least because of the number of times I've been asked for my reaction to it over the last six months--a sure sign that its message is seeping into the public's consciousness. This well-made film manages to be interesting and even occasionally amusing, while answering the question of how one can make a 90-minute film about a Powerpoint presentation. Although I didn't agree with every aspect of it, particularly its treatment of the more extreme consequences of climate change, I can recommend it as something that every informed American should see.

If you're going to see it, and you haven't read any recent reviews of it, you should know that while it is certainly about climate change, it is also very much about Al Gore and his long engagement with the issue. As a result, it must be viewed as a partisan political film. It takes shots at Republican administrations, past and present, while lauding the actions of the administration in which Mr. Gore served. The film is also surprisingly personal in places, and Mr. Gore's anecdotes about a tragedy and near-tragedy in his family helped humanize his message and explain his resolve, without seeming exploitative.

The other key fact about "An Inconvenient Truth" is that it is unabashedly intended to persuade, rather than merely describe. Mr. Gore's arguments are laid out in a logical progression, but they don't include many caveats. Uncertainties and complexities are generally glossed over, and assumptions are not explored to any great degree. In addition, he dismisses climate skeptics as misguided or disqualifies them on the basis of their connections to large corporations, while ignoring the implications of the vast grant-making machine that climate change science has become. And for a globe-spanning production about this most global of problems, it conveys an oddly US-centric undertone, as if we were the only impediment to solving the problem.

My biggest surprise in watching "An Inconvenient Truth" was my own reaction to it. A new reader of this blog might misinterpret my comments above as indicating some skepticism about global warming, when I'm actually convinced that it is real, man-made to a significant degree, and extremely challenging. I just think there's a different way to tell the story--as I have tried to do here over the last three years--emphasizing the prudent management of these large risks and their attendant human and financial costs. I also believe it's important to convey clearly and honestly that this problem can't be resolved quickly, simply, or cheaply, because its causes are so deeply embedded in the infrastructure of our civilization.

When "An Inconvenient Truth" came out in May, I looked at the various reactions it generated, and I questioned whether Mr. Gore was really the best spokesman to convey the climate change message to skeptics. Having seen it, I cannot imagine this film having been made any other way, because its subject encompasses not just the details of climate change, but also the political reaction to them and Mr. Gore's involvement with the process. So although I regard Tom Brokaw's Discovery Channel special as a better factual overview of global warming for a general audience, the Gore film does a fine job of previewing the intense political debate that must precede any national commitment to a stronger response to this problem. That discussion could start as soon as next January, with the new Congress.

Tuesday, December 19, 2006

One of the trends I've been following this year has been the reemergence of energy security and energy independence as major topics of public debate and discourse. Credit the "Geo-Greens" with putting the "strange bedfellows" approach to this on the map. Now to the various national security/environmentalist combinations we must add a new group, the Energy Security Leadership Council, an alignment of business and retired military leaders that has received favorable press, including a fascinating article on the front page of today's Wall Street Journal, concerning the military dimension of energy security. I believe this trend will grow, as the new Congress seeks to put its stamp on energy, and as long as oil and gas prices remain well above historical levels. At the same time, we should differentiate between strategies that will require decades to implement fully, those that can begin to make a difference right away, and those that must be held in reserve in case of a near-term disruption in supplies.

The WSJ article, in particular, describes the urgent need to redefine energy security in the context of today's highly complex, multi-risk global situation. Although not specifically mentioned, that ought to include a serious review of the 1970s institutions that were established to deal with earlier manifestations of energy risk, in a bi-polar world dominated by the US/USSR rivalry and Arab/Israeli conflicts. The outdated system of national strategic petroleum reserves--with China currently engaged in building its own SPR--may not be adequate to handle a sustained, coordinated assault on energy infrastructure in both exporting and importing countries.

Any substantial reduction in our import requirements, as contemplated by many energy security/energy independence-focused groups, will entail significant time lags, about which I've written at length. (I will re-run one of those postings next week.) Rigorous analysis of these constraints leads to the inescapable conclusion that energy independence, as most of us would define it, is simply not possible soon enough to extricate us from our current global challenges. Furthermore, it is out of step with the increasing inter-connection of the rest of the global economy, reflecting in many ways a resurgence of the old populist-isolationist strain of American politics.

Energy security and energy independence are distinctly different notions, and this is not hair-splitting. Reducing our reliance on unstable suppliers and making much better use of the energy we do import is prudent and desirable; thinking we can or ought to be autonomous is not. In fact, we haven't been energy independent since the 1950s, when the US economy and population were much smaller, and domestic oil production had yet to peak.

The missing ingredient in many of these discussions, however, is realistic contingency planning for the energy crises that might occur within five to ten years, before the long-term elements of energy security can contribute meaningfully. I regard this as particularly urgent, given the post-Katrina response of the Congress to the way that a free market regulates demand and distribution through higher prices, defined by far too many as "gouging." If higher prices and no gas lines is an incompatible combination in our political culture, then we'd better have something else waiting in the wings, such as an updated World War II-style rationing system, perhaps based on debit card technology. Simply freezing fuel prices in a crisis, with 120% more cars on the road than in 1970 and a much greater reliance on interstate trucking of freight, would produce outages and gas lines that would make those of 1973-79 look trivial.

Whether we call it energy security or energy independence, a national debate on this topic is long overdue. We need to weigh the relative merits of all our energy options and prioritize among biofuels, unconventional hydrocarbons (e.g., oil sands and shale,) renewable electricity and nuclear power. Out of this, we must create an energy plan that targets a new energy mix for 2030 and describes the details of the transition from the current mix. Once that's in place, we can explain to the public--and our suppliers--how the global energy equation will gradually shift back in favor of consuming countries. I can't imagine a better project on which to cooperate with the EU and China, which face the same challenges.

Monday, December 18, 2006

It's easy to see Shell's current difficulties in Russia as part and parcel of the broad reassertion of centralized authority by the Russian government, particularly in the energy sector, and its increasing use of energy to create leverage over its neighbors. Shell and its Japanese partners seem prepared to sell a large, probably controlling interest in the Sakhalin-2 natural gas project to Gazprom, the partially-privatized Russian state natural gas enterprise, in order to keep the project alive. This move fits a pattern that includes the forced re-nationalization of Yukos and last winter's heavy-handed gas supply dispute with Ukraine, which may shortly be replayed in Belarus and Georgia. But as Reuters points out in the news item linked above, there's another factor at play in Sakhalin. Gazprom cannot translate its dominance in natural gas reserves into a dominant global market position without LNG expertise and capacity.

It's a tired cliche that Americans play football and Russians play chess, but that's still a good reminder of the Russian disposition towards strategy. In that light, Sakhalin-2 isn't just a business dispute between a major oil company and a host country that has employed a variety of means, fair and not so fair, to muscle its way into a potentially lucrative, world-scale LNG project. It's a major strategic move for a company that has already become a key instrument of Russian foreign policy in Europe and the "near abroad"--the Eastern European and Central Asian states that were once part of the USSR, or abutted it.

Just as Russia was traditionally a continental power, capable of asserting influence across the entire Eurasian land mass, but with limited sea power, Gazprom's market and influence is currently limited to where its pipelines can reach. The natural gas market will become increasingly globalized in the years ahead, with the expected rapid expansion of LNG trade. Without the ability to supply gas across the oceans, Gazprom would miss out on much of the growth in this market, especially in the US, where LNG is still in its infancy. That could be very costly, particularly if Europe turns elsewhere for the gas it will need to meet its commitments under the Kyoto Treaty.

The ultimate roots of Gazprom's LNG strategy--and thus its actions with regard to Sakhalin-2--lie in the inherent contradictions of the US gas market, where environmental regulation has simultaneously nurtured the growth of gas demand, while stifling its domestic supply from federal lands and offshore drilling. If I were running the world's largest natural gas company, I would not rest until I was properly positioned to participate in what is likely to be the world's largest market for LNG. Shell and its partners just happen to be in the unfortunate position of providing both the means for achieving that end, and an obstacle in its way.

Friday, December 15, 2006

With the end of the year approaching, this weblog is closing in on its third birthday. Until now, my blogging has been done entirely at my own expense, as an adjunct to my energy and strategy consulting activities. Today, I am happy to announce the addition of a major sponsor, John S. Herold, Inc., a provider of research and analysis on and to the energy industry. Aside from funding and providing me with access to more detailed sources of information, this new relationship won’t affect the focus, tone or independence of my writing.

I’ve thought very carefully about how best to commercialize this site without diluting its message or raising concerns about my objectivity. From the start I ruled out Blogger’s banner ad program as too distracting. Earlier this year, I turned down another sponsorship offer from a very large, household-name corporation, because it would have instantly altered my readers’ perception of my motives. John S. Herold, Inc., for whom I have also consulted, brings significant benefits without these drawbacks.

So what will change? Other than the addition of a link to my sponsor’s public website and portal to their client-only material, I will continue to post on essentially the same schedule as before. Herold will re-publish this blog for their clientele, with a private comment area. I still intend to respond to your comments on this site, as appropriate. From time to time, I may also link to some client-only material at Herold, which will be clearly identified as such. If that motivates you to sign up for their service, I’m sure my sponsor would be pleased.

Energy Outlook was originally inspired by my sense that I could help fill an important gap between this highly technical “pillar” industry of our economy, the government that regulates it, and the public that depends on it and invests in it, but often doesn’t understand all its complexities. Along the way, this platform has acquired a reputation for insightful analysis and has expanded from a monolog into an ongoing conversation with interested readers, who bring their own relevant expertise. Aside from having a new sponsor, the viewpoint and topics that brought you here—and that attracted Herold—will still be here, pretty much every business day.

Thursday, December 14, 2006

The report of the Iraq Study Group was released just over a week ago. As expected, it contained no silver bullets, but rather a list of 79 recommendations that are no less controversial for their practicality. Setting aside the national-strategic questions the report poses, I believe its implications for energy markets fall into two categories: what happens if the ISG's recommendations are implemented, and what happens if they aren't, or can't be put into effect? Either way, there isn't a lot of upside here, by way of factors that would promote increased oil production from Iraq, while easing the growing risks of regional instability that are weighing on the market.

The ISG explicitly recognizes oil as the engine of Iraq’s future growth, and its recommendations for the oil sector are generally sensible and straightforward. At the highest level, they propose reducing the centrifugal influence of the Iraqi constitution's provision allowing the country's regions to claim the full benefit of future oil discovered on their territories. This would be achieved via a proportional revenue sharing mechanism, which is in the works, and the reorganization of the oil industry along commercial lines, incorporating international standards and practices. The report also highlights the need to reduce oil-related corruption, which siphons off between 5-25% of the country’s production, though that upper bound stretches credulity. Metering oil volumes at both ends of the pipelines, as the ISG suggests, would at least increase transparency and reduce the opportunity for large-scale smuggling.

Some of the ISG’s oil-related recommendations are more problematic. Although the US learned its own bitter lessons about the consequences of holding gasoline prices below market-clearing levels in the 1970s, de-controlling petroleum product prices in a dysfunctional Iraqi economy might easily make things worse, rather than better, and add to civil unrest. At the same time, the proposal to increase the involvement of the US military in securing Iraqi oil assets would create visible contradictions to the suggested reiteration by President Bush that the US does not seek to control Iraq’s oil. Proposals for improving the country’s legal framework to promote international investment in the oil sector are important, but wouldn’t be effective as long as the security situation remains unsettled.

That last point is the crux of the whole problem. The impact of the report’s good ideas for the oil sector will be entirely secondary to the success of its primary recommendations for resolving the unfolding civil conflagration in Iraq, and for creating the basis on which the US can withdraw its forces—sooner or later--while leaving behind a stable, self-governing country. If the Baker-Hamilton Report represents the blueprint for achieving these goals, as many believe, then the initial reaction of the Iraqi government--which must be a full partner in the implementation of these recommendations--isn’t a good sign.

At best, if every recommendation of the Baker-Hamilton team were put in place, the report suggests that oil production might return to its pre-war potential of 3 million barrels per day or so. That would enable exports to increase from their current level of 1.3-1.7 million barrels per day to well over 2 MBD. Otherwise, the downside ranges from bad—the steady deterioration of the industry from the stresses of war and corruption—to spectacularly bad, if Iraq’s instability spreads to its oil-producing neighbors, or if its central government collapses and US forces must fight their way out of the country, echoing Britain’s First Afghan War. In the worst case, the US could find itself backing Iraq’s Shiites in a full-blown civil war against Sunnis supported by Saudi Arabia.

Many of the fundamentals in the global oil market seem to be bearish, just now, with OPEC trying to find the right formula for cutting production to avert a glut next year. But overlaying the likely scenarios for Iraq onto this picture, we have all the ingredients for a highly volatile, risk- and news-driven market throughout 2007 and into 2008. Expanding capacity in Saudi Arabia and elsewhere may buffer the impact of events within Iraq, but if they spill over, oil prices could spike higher than this summer’s peak of $77/barrel.

Note: Publication of this blog was delayed by technical problems accessing the internet.

Wednesday, December 13, 2006

The Pacific Northwest National Laboratory (PNL) of the Department of Energy has just released a study addressing the capacity of the US electricity grid to handle the additional electricity demand associated with the widespread adoption of plug-in hybrid cars. They found that existing power plants and transmission lines could support the equivalent of 84% of today's vehicles, provided they recharged during off-peak times. That is welcome news for those who see plug-in hybrids as a key contributor to reducing our reliance on imported oil and cutting vehicle emissions. Analyzing the results further, however, suggests that PNL's finding is necessary, but not sufficient for making such cars a practical alternative to cars that rely on liquid fuels for all their energy needs.

I applaud PNL for thinking big and looking ahead to a time when plug-in hybrids might be truly mainstream, rather than unique prototypes or home conversions. It's easy to justify putting the first few thousand plug-ins on the road, but before they can replace all conventional cars, we need to answer a long list of questions, including:

Can existing power plants and distribution networks, including the regional grids that make up the US electricity supply backbone, handle the additional load of millions of electric vehicles. According to PNL, the answer is yes, at least in the Midwest and Northeast, provided they recharge off-peak.

Would the result of such a shift reduce US greenhouse gas emissions? Although I couldn't find the specifics on the PNL site, an article on the study in yesterday's Wall Street Journal indicated that full conversion to plug-ins, presumably using the current mix of coal and natural gas-fired power plants with extra off-peak capacity, would cut GHGs by about 5%. That's much less than what one might expect from such a radical change in the sector responsible for one-third of all US CO2 emissions.

Would the economics of a plug-in hybrid make sense for consumers without massive government subsidies? PNL suggests that the payout would be between 5 and 8 years. They interpret that as a yes, but I question both the figures and their interpretation.

Could domestic coal and gas supplies support the increased demand from power plants involved in a massive shift from gasoline to plug-in hybrids? PNL didn't seem to have addressed this, but I believe this is a big concern, at least for gas. If US natural gas supplies are tight--and expensive--with hardly any now going into transportation, where would the incremental gas come from to fuel the off-peak combined-cycle generating capacity that would recharge many plug-ins? The answer would have to be either LNG, or shifting gas away from other demand sectors.

If plug-in hybrids reduced overall gasoline consumption dramatically, would their electricity consumption continue to be exempt from the highway taxes collected on liquid fuels, and if so, how would highway maintenance be funded? This is a policy question, but if we're looking at the big picture, it can't be ignored.

The vehicle-level economics, in particular, deserve more attention, since they represent a much larger up-front investment than current hybrids, the sales of which seem to have slowed, as gasoline prices have come down from the summer peak. At $2.50/gallon, the average fuel bill of the average car in America is $1,200/year. If, as PNL suggests, the plug-in hybrid upgrade costs $6,000-10,000/car, then even if electricity were free, the payout period would stretch beyond the typical initial car ownership period. It would have to be reflected in much higher resale values, in order to avoid dramatically increasing the average cost of vehicle operation. As I've shown before, plug-ins will face very tough competition from conventional hybrids that capture the most valuable increments of fuel economy, leaving much less benefit from which plug-ins can justify their added cost.

As encouraging as I find PNL's announcement in terms of keeping an important energy option open, we're left with a lot of unanswered questions, not the least of which is whether such a strategy should even be contemplated without a dramatic shift in our electric generation capacity away from fossil fuels and toward nuclear power and renewables. As the PNL study shows, the current generating capacity can't deliver big greenhouse gas reductions from a switch to plug-in hybrids, and the extra coal and natural gas to fuel it present equally serious hurdles.

Tuesday, December 12, 2006

In one of its last acts the 109th Congress approved a modest expansion of the portion of the Gulf of Mexico available for offshore oil and gas drilling. The bill that finally passed was based on the earlier Senate version, rather than the much more ambitious House design, which would have lifted the broad federal offshore drilling ban. Although new supplies from the eastern Gulf will be welcome, as they come onstream over the next 7-15 years, the result falls well short of the kind of offshore drilling reform we really need. That's not necessarily a bad thing, given the desirability of avoiding haste in such an important matter. However, with the expected shift in focus from energy supply to demand with the incoming Democratic Congress, the deeper conversation on this is unlikely to be a priority.

In order to understand why more offshore drilling shouldn't be off the table permanently, as many environmentalists hope and expect, we must examine our entire energy supply, which can be reduced to a fairly simple picture. Although alternative energy is growing rapidly from its small base, our current energy supply derives overwhelmingly (94%) from four sources, in declining order of importance: oil, coal, natural gas, and nuclear power, with renewables (mostly hydroelectric power and biomass, including ethanol) bringing up the tail. Oil typically gets the most attention, because it's both our largest source and the key to transportation. It also accounts for most of our energy imports.

With US oil demand continuing to grow, while our domestic supply shrinks due to the depletion of mature oil fields, the import gap widens with each passing year. The essential first step towards greater energy security, and ultimately the energy independence we hear about so often, is to halt the increase in US oil demand and simultaneously stem the decline in US oil production. That would allow us to freeze oil imports--not as a strategy in itself, as some suggest, but as a consequence of more basic strategies.

The Democrats will arrive in January with renewed enthusiasm for attacking demand, including ideas such as higher automobile efficiency standards, expanded supplies of oil substitutes, and possibly some form of gasoline or carbon taxation. Even with dedication and creativity, getting demand growth under control will be a monumental task, since all the trends are working against it. If the new Congress and the administration work together to achieve this difficult goal, but don't also act to maintain oil production at at least today's level, then we will continue to lose ground.

After six years of focusing heavily on measures to increase oil production, helped along by high oil prices, it's natural and even urgent that we give the demand side of the equation at least as much attention. But if in the process we lose sight of the necessary contribution of sustained oil drilling, these efforts will ultimately fail, as natural depletion and the growing vulnerability of our remaining supplies to Gulf Coast hurricanes erode our existing supply base. If it takes a bi-partisan commission on energy to remind us of that basic truth, then perhaps that's in order.

Monday, December 11, 2006

These days, most conversations about energy security inevitably turn to biofuels, and to ethanol in particular. Unlike hydrogen, ethanol is compatible with essentially every gasoline-powered car on the road today--at least in blends up to 10% ethanol--and with the existing petroleum products distribution system, except for pipelines. It is largely home-grown, and production is expanding at a remarkable rate, building from 1.8 billion gallons in 2001 to nearly 5 billion gallons this year. Ethanol supporters, including members of Congress on both sides of the aisle, expect it to grow at least as much over the next five years. But as ethanol moves out of the small niche that it has filled until recently, we must begin to consider how ethanol will affect the price of motor fuels in the US when it accounts for 20 or 30% of the market, rather than 2%. An article on the milk industry in Sunday's Washington Post provides a cautionary tale for ethanol's future.

Few sectors of the American economy are more heavily regulated than agriculture, and few markets are more distorted by the influence of regulations and subsidies than those for the products of agriculture, and milk is no exception. The Post article details the struggles of a maverick dairy owner who tried to work outside the federal and industry price-support system, lowering prices to consumers in the process. According to the Post, the industry responded by using its influence to promote legislation that brought Mr. Hettinga back into the system, against his will and at considerable expense. Now, we can debate which state of affairs is in the greater long-term interest of consumers, a free market in which people like Mr. Hettinga can innovate and pass along the savings, or one in which supply is carefully managed and prices are effectively controlled to limit competition. Either way, despite the importance of milk in the American diet, the result doesn't change our lives very much. Fuelling our cars is a different story.

For the last three decades, ethanol for cars has been a creature of government regulations and subsidies, and I don't see that changing any time soon. The current boom in ethanol, which has benefited so many farm communities in the Midwest, would be much smaller in extent without the 51-cent per gallon ethanol tax credit, various state incentives, and a web of federal and state renewable fuel standards, which mandate the use of increased percentages of fuels like ethanol.

Setting aside all of the technical issues that have bedeviled ethanol, including its low energy return, constraints on shipping it in pipelines, and an energy energy content at least 20% lower than gasoline by volume, we need to think seriously about the structure of the future ethanol market, and by extension the larger market for motor fuels in this country. One of the public's biggest concerns about gasoline is that they see its production and distribution dominated by a small number of very large oil companies, which they believe control prices to their advantage. Never mind that OPEC, not the majors, manages the price of oil by restricting its supply, or that government intervention, in the form of pervasive environmental regulations and permitting restrictions, has created most of the structural problems that give rise to the public's concerns about gasoline pricing. Perception counts for a lot, and the industry has never dispelled the public's doubts in this area.

In the process of reducing our reliance on the Middle East, a topic to which I will return in the next day or two, we ought to ensure that we don't exchange one controlled market for another. Having the price of gas at the pump set by an approved cartel of large ethanol producers--and don't think that the ethanol business will be anything less than Big Business in the future--won't be any more satisfying for consumers than having it set indirectly by a small group of Middle Eastern and Latin American national oil companies.

How do we prevent such an outcome? It won't be easy, but a good first step would be to announce the gradual phaseout of the ethanol subsidy, say over 10 years, while offering a narrower range of incentives skewed toward small companies, new technologies, and new entrants, rather than large, established ethanol producers. If we're going to pin our energy hopes on ethanol to any larger degree than we already have, then it should have to compete on a level playing field, at least relative to other domestic energy sources.

Friday, December 08, 2006

With the Midwest and Northeast finally getting a taste of colder temperatures, the cost of winter heating is back on consumers' minds. The Department of Energy has estimated that the average US household will spend $860 for natural gas or $1550 for heating oil this season, down 9% and up 6% from last year, respectively. For those on low or fixed incomes, this is a real burden, and a broad array of federal, state, local and private agencies provide discounts and other assistance to help low-income people heat their homes. So it sets my teeth on edge to read headlines such as the one in yesterday's Washington Examiner, "Venezuela's Hugo Chavez delivers cheap oil to Baltimore's poor." I'm not sure who should be more embarrassed by this: President Chavez for thinking he can influence American voters with the same techniques he uses at home, or American companies for letting a foreign dictator score PR points this way.

It's not just that Hugo Chavez is hardly my favorite world leader. Set aside that this program to help poor people in the US represents yet another means for Sr. Chavez to spend his under-developed country's wealth on enhancing his own reputation, rather than Venezuelans' well-being. Perhaps the lost revenue on a product that "obviously...is never used in Venezuela" wouldn't be tallied, anyway, in Bolivarian economics. Mainly, I regard heating oil assistance as yet another instance of letting him beat us at our own game.

When they hear about this program, I'm sure many Americans will be puzzled that Citgo, Venezuela's wholly-owned US subsidiary, was the only oil company to respond to the solicitation for assistance from Joseph Kennedy's Citizens Energy Corp. The structure of the heating oil market bears at least some of the blame for this. To my knowledge, none of the major oil companies sells heating oil directly to consumers, other than independent refiner Valero, through its Ultramar subsidiary, or Sunoco in the Philadelphia area. Instead, they sell their output in the spot market or to distributors who re-sell under their own house brands. In order to offer low-income heating oil discounts, the majors would have to rely on these distributors to pass them on, and they wouldn't get any recognition for it. It's hard enough to make sure your distributors are selling your products, rather than your competitors', and the laws surrounding these relationships would inhibit the intrusion required to audit low-income sales.

In a year that has been as good to oil companies as 2006 has been, this structural impediment could probably be overcome with a bit of creativity and determination. But corporate philanthropy in this industry, as in many others, has generally narrowed its focus to efforts that contribute directly to brand recognition and reputation, by influencing opinion leaders. In an era when customer relationships are managed by data mining, how many CEOs would say that it is within the purview of their company, rather than the government, to buffer the impact of the market on individuals? But while I understand why ExxonMobil, Chevron, ConocoPhillips, BP and Shell haven't matched Citgo in offering heating oil relief, the result still casts them as Mr. Potter to Hugo Chavez's Jimmy Stewart.

Thursday, December 07, 2006

Ever since reading about a nifty invention a couple of weeks ago in MIT's Technology Review, I've been thinking about its implications. An MIT physicist has come up with a practical way to recharge laptops, cellphones, digital cameras, etc. without plugging them in. Wireless is certainly all the rage in communications, so why not for power transmission, at least for some applications? After all, carrying around all those plugs and adapters is inconvenient, and inadvertently walking out of the house with an uncharged device is annoying or worse. There's no free lunch, however, and this piece of progress comes at a fairly hefty cost, with energy losses of 50% or more. As much as I love the idea of wireless power, I have a hard time justifying the price of this extra convenience, when we are trying to save energy, rather than wasting it.

As the TR article suggests, the basic concept isn't new. Scientists have talked about broadcasting power ever since Tesla, and long-distance microwave power transmission is central to the possibility of space solar power. For that matter, there are already industrial applications of a similar concept. But Dr. Soljačić's approach to inductive recharging seems novel, with the power being transferred by magnetic fields over a distance of a few meters, but interacting only with devices attuned to receive it. Ignoring the extensive product safety testing that would have to take place before anything like this could be installed in homes or businesses--if cellphones emitting milliwatts concern us, immersing ourselves in a soup of tens or hundreds of watts ought to have us jumping out of our skins--we need to ask ourselves about the concrete benefits this technology could bring.

If all that wireless power offers is to replace something we can already do perfectly well with wires, is it worth the energy loss to gain a little extra flexibility? With energy efficiency experts campaigning to stamp out "vampires"--those devices in our homes and offices that are on even when they seem to be off--how can it make sense to add another 50% loss to the end of the transmission chain, cutting end-to-end energy efficiencies in half? Perhaps an analogy to the early days of the internet is appropriate. Some of the first applications of the web also took things we could do perfectly well in other media and simply adapted them. The real value of the web has come from applications that wouldn't have been possible otherwise, especially involving interactivity and immediacy.

What could wireless power enable us to do that we can't do now? Most of the applications that occur to me off-hand are still in the realm of science fiction, such as "smart dust" surveillance/communications networks, or very large ultra-thin displays. On a larger scale, wireless power might overcome the range limitations that have prevented battery cars from going mass-market. That could take the idea of the plug-in hybrid car one step farther, by providing hundreds of miles of gasoline-free driving range on special highways offering inductive recharging.

One of the biggest challenges with this sort of technology is that the truly unique, compelling applications for it typically don't turn up until after the enabling technology is in place. That makes it hard to justify investing in the initial innovation, running the risk that there might never be such a killer ap. In that case we could end up wasting megawatts of electricity and generating megatons of extra greenhouse gas emissions just to eliminate a few pesky power cords. I'd love to see what some really creative folks could do with this idea.

Wednesday, December 06, 2006

Tom Friedman's NY Times column (Times Select required) today is devoted to China's solar power mogul, Shi Zhengrong, the founder of Suntech Power Holdings, a manufacturer of solar photovoltaic (PV) cells. While describing the mix of government incentives and low labor costs that have helped make Suntech successful, Mr. Friedman laments that we haven't forced US companies along a similar path. Aside from the shaky economics involved in this comparison, Mr. Friedman, generally a supporter of flat-earth free trade, ignores the global benefits of having China in the forefront of the clean-tech revolution. The Chinese aren't the only ones who will benefit from cleaning up China's skies, and reducing the rapid growth of its greenhouse gas emissions.

The concept of technology leapfrogging was certainly exaggerated and over-used in the 1990s, as a way to justify risky high tech investments in developing countries. At its core, though, is an important idea that's equally valid in the world of energy and environmental projects: putting in the best available technology at the start often avoids costly compromises later, and can even save money up front, by avoiding extra infrastructure. With China currently adding the equivalent of the entire UK power grid every year or two, there ought to be plenty of scope for renewables-based distributed power solutions, particularly if companies like Suntech can keep driving down the cost of a PV module. As many US manufacturers have learned the hard way, this is something at which Chinese firms excel.

Given the combination of high energy prices and the growing entrepreneurial focus on clean energy, I'm confident that the US won't lack for green products that match our economic circumstances. Meanwhile, whether it's driven by leapfrogging or by the simple notion that China can't follow the same development path as the US and Europe without stretching global commodity markets and the environment to the breaking point, we should all want China to get very good at deploying alternative energy and efficiency technology. Their need is greater, and the opportunity larger. Let's worry less about whether they're stealing a march on us, in the process.

Tuesday, December 05, 2006

Two stories in today's Wall Street Journal illustrate one of the inevitable consequences of our shift away from fossil fuels and toward renewables, which are generally much more diffuse. The front page of the Journal carried a lengthy exposé (subscription may be required) on the damage to the Borneo rainforest, shared between Indonesia and Malaysia, caused by these countries' efforts to expand palm oil production for biofuel. Another piece looked at the expansion of concentrated solar power (CSP) collectors in Spain. In both cases, the footprint of renewable energy is much larger than that of the traditional energy sources it is meant to augment or displace. With non-hydro-electric renewable energy still supplying only a few percent of global energy demand, this trend is in its very early stages. Although the final verdict on the sustainability of this effort is unresolved, the conversion to renewable energy will indisputably transform the earth's surface as much as any past endeavor of mankind.

This isn't intended as a criticism of renewable energy, per se. Rather, it's a reminder that every choice we make concerning energy carries consequences. Oil and gas have their own problems, but as their technology has improved, developments such as 3-d seismic and horizontal drilling have reduced their footprint on the landscape, by boosting the productivity of each well drilled. Fundamentally, though, even where the countryside has been turned into a veritable moonscape of pumping units, pipelines and cogeneration steam generators, such as in the Kern River and Midway-Sunset oil fields near Bakersfield, California, the energy produced from this modest patch of land exceeds the entire net contribution of all the corn that's turned into ethanol in the Midwest. Oil and gas are highly-concentrated vintage sunlight, and our efforts to harness today's sunlight--including the wind it creates--must necessarily cover vast expanses of land or sea, to capture equivalent quantities of energy.

To the long-standing land-use competition among wilderness, agriculture (for food), recreation, and human habitation, we must now add "energy farming." The latter encompasses wind, solar, and biofuels, and it complicates an already intricate dance between the forces of development and preservation. I've devoted a lot of space on this blog to my concerns about over-estimating rate at which alternatives can replace conventional fuels, largely as a function of the time lags involved. However, I think this competition for surface area could be just as important, because it naturally leads to the NIMBY-ish constraints that have already slowed the development of wind power, at least here and in the UK. Unless we see rapid progress in some new highly-concentrated form of energy, such as the dry-rock geothermal energy mentioned in a comment on yesterday's posting, we're going to be dealing with this problem for generations.

Monday, December 04, 2006

An article in Saturday's Washington Post and an editorial in today's Wall Street Journal reflect the growing focus on how business responds to climate change. Joel Garreau's Post article explains in clear, practical terms how the insurance industry is reacting, and how that reaction is changing the cost of home-ownership for anyone living near a vulnerable coastline. Insurance companies have progressed beyond the debate on climate science to deal directly with climate risk and the way it distorts the statistical models upon which they depend. The Journal editorial, on the other hand, addresses the unwelcome attention that one of the largest climate skeptics in the world, ExxonMobil, is receiving. The price of skepticism is increasing, and the implications of the gathering political backlash are unpredictable and scary, from the perspective of corporate boards and shareholders.

Mr. Garreau is not just a reporter, but a noted futurist and deep thinker on urban and land-use planning. If you own coastal property or aspire to, his must-read article will send chills down your spine. The financial pressures he describes could make the current national slump in home sales look like a boom market, with many existing coastal structures and building lots potentially becoming uninsurable in the near or medium-term future. In this respect, an insurance policy is like a time machine from the future; it transforms the latest view of future climate risks into a greatly increased current cost--or a policy cancellation. We don't have to wait for Al Gore's predictions to come true, because the outcome has been built into your annual premium.

Yet while "insurance companies approach climate change bracingly free of theory," others, such as ExxonMobil, skew in the opposite direction. Today's Wall St. Journal vigorously defends Exxon's right to skepticism, and to support other skeptics, in the face of an intimidating communication from two senior US Senators. In their October 27 letter to Exxon's CEO, Senators Rockefeller and Snow issue either an informal cease-and-desist order, or a thinly-veiled threat, depending on your interpretation.

Even though I have long disagreed with Exxon's approach to climate change, and personally had a hand in making one of their competitor's climate policies much more pro-active, my gut reaction is not far from the Journal's: if a publicly-traded corporation wishes to underwrite research establishing that the moon is made of green cheese, that ought to be between them, their shareholders, and their customers. However much I am persuaded of the validity of climate change theory and the evidence that supports it, it has a ways to go to attain the certainty of the Theory of Gravitation, or of Maxwell's equations of Electromagnetism.

The risks facing energy companies and insurers look quite different. If an insurance or reinsurance company underestimates the impact of climate change on its future claims, it will suffer large losses and might go out of business. If it overestimates them, it will write fewer policies, but they will be more profitable. If an energy company underestimates the risks, it faces lower sales, higher taxes, and some collateral damage to facilities, but all of that is survivable, and possibly even hedge-able. If it overestimates the risk, it will invest too much in projects and technologies that will not pay off, and not enough in more conventional activities that are its--and its shareholders'--bread and butter. It's not hard to see which firm has the greater incentive to be proactive. If science and economics were the only factors at play, that would be the end of the story; businesses would choose how to deal with these risks, and events and the market would punish and reward them accordingly.

However, we cannot ignore the growing importance of politics and public perception in this area, along with a strong trend toward greater accountability for past corporate mistakes. The political winds are changing, and it appears likely that the large gap between the US and Europe on climate change will narrow. Companies that are already moving in this direction will prosper, while those that don't will become increasingly isolated and vulnerable. The best advice I can give ExxonMobil is the same as I gave Texaco in the late 1990s: Nothing you say against climate change is credible. Your choice is between being seen as part of the problem, or part of the solution.

Friday, December 01, 2006

A fascinating op-ed in Wednesday's New York Times put a clever new spin on the old "Limits to Growth" arguments of the 1970s, extending their application from raw materials to encompass innovation, particularly as it concerns our long-term energy supplies. The author, a social scientist, focused on the falling "energy return on investment" or EROI of oil and gas resources over the last several decades, as a key indicator of the shrinking energy surplus available to our society. This is important because energy surpluses generate economic surpluses. While this may sound overly abstract, compared to more practical discussions about competing alternative energy technologies and infrastructure, this debate is an important component--even a precursor--of an intelligent energy strategy.

There was a lively discussion about EROI in the comments area of this blog a few months ago, precipitated by some inaccurate comparisons of the ethanol and gasoline EROIs by biofuels advocates. The current 1.3:1 energy return for corn ethanol--with aspirations of 2:1 or better for future ethanol plants--compares poorly with the 15:1 return for oil cited by Dr. Homer-Dixon, though not quite so badly with the 4:1 return he gives for oil sands extraction. At that level, though, what counts is not which one is better, but whether either is sufficient to underpin a global economy of $44 trillion, and growing.

The problems Dr. Homer-Dixon highlighted are genuine and important, particularly in terms of the constraints that climate change imposes on our search for high-return alternatives to oil. Where I depart from his logic, however, is in his conclusion that we are running up against the limits of energy innovation. Our main challenge isn't one of energy availability, but of the ready means to convert the vast quantities of energy that surround us into useful work. The natural environment is brimming with energy, in the form of wind, sunlight, geothermal heat, and tides, all of which contain orders of magnitude more energy than our civilization's annual energy budget of 440 quadrillion BTUs. And that only counts what's available on the surface of the earth; the energy passing through the earth's orbit every year is vastly greater. There is abundant evidence of new innovation in tapping into these supplies.

Consider the prospect of space-based solar power (SSP), which unlike nuclear fusion (see Monday's posting) could be achieved in much less than 40 years. The biggest impediment to building it is the lack of a large-scale, low-cost space launch capability, something far in excess of the Shuttle fleet, or its anticipated successor. When you factor in the cost of creating the capability to construct and launch a structure many times larger than the International Space Station, and then assembling it in orbit in a couple of years, rather than a decade or more, and then attribute all of this to SSP, the EROI of the first few 5,000 MW solar power satellites (SPS) looks appallingly low--probably even negative. But we wouldn't create that capability just to build one or two SPSs; it only makes sense if we build a fleet of them. Nuclear power would have had a similar problem in its early days, before fielding 100 nuclear reactors in this country.

Whether you're looking at a long-term option like SSP or fusion, or a current alternative such as wind power, the basis of the EROI comparison ought to be at maturity, e.g. when wind is supplying 15% of US electricity, not at its initial, very low market penetration. In order to generate sustainable global economic growth far into the future, we must either have a solid slate of high-EROI energy sources lined up, or we must de-couple energy and GDP altogether. Although we may be on the downward slope of EROI for fossil fuels, we don't lack high-return options for their long-term replacement.

Thursday, November 30, 2006

GM's announcement that it intends to build plug-in hybrid cars can be interpreted in several ways. Clearly, some will see this as mere marketing hype from a company that has so far fielded only "mild hybrids" and one true hybrid that is still in its first model year. On the other hand, it may be a sign that GM understands the degree to which it has yielded the technological lead to Toyota and Honda, which have second-generation hybrids on the road and third-generation hybrids on the drawing boards. Given the growing importance of the Chinese market to GM's profitability, and in light of China's new, tougher fuel economy standards, the company that brought us the Hummer might just be starting to get it, concerning fuel economy.

When journalists mention plug-in hybrids, which supplement a hybrid car's recovery and electrical storage of braking energy with an overnight recharging capability, they usually focus on the batteries. These must be more robust than for a regular hybrid, and some engineers argue that they should employ different chemistry, as well, given the very different charge/drain cycling involved in all-electric driving. The other part of this equation, of course, is the motors. In order to deliver acceptable performance (see yesterday's posting) a plug-in must have a fully parallel drivetrain, powerful enough to accelerate the car safely without constantly resorting to the gasoline engine. That redundancy, along with the heavier-duty batteries and electronics, substantially increases the cost premium over "conventional hybrids"--a term that would have been an oxymoron a few years ago.

It's a long way from the Chevy Silverado Hybrid, with its bigger battery and starter motor that provide instant on/instant off at traffic lights--contributing minimally to powering the car while in motion--to a full plug-in hybrid car or SUV. If these mild hybrids and the new Saturn constituted GM's only experience in this area, the road ahead would be very steep, indeed. However, despite all the grief GM has taken for killing it, including allegations of a conspiracy, the EV-1 battery car of the 1990s established GM's bona fides in the field of electric propulsion. The legendary enthusiasm of those who leased that model while it was available represents a strong vote of confidence in GM's ability to produce a practical and attractive plug-in hybrid in a few years, provided GM can remain solvent long enough to deliver on this promise.

Wednesday, November 29, 2006

With the Supreme Court due to hear arguments today on a landmark case covering the authority of the EPA to regulate greenhouse gas emissions as pollutants, the San Francisco Chronicle yesterday addressed the question of whether limits on tailpipe CO2 emissions would spell the end of large SUVs, at least in California. While I agree with their assessment that technology can deliver at least the 30% reduction in fuel consumption implied by the emissions limits, they omitted a crucial factor in this equation: consumer expectations. Instead of heralding the end of the SUV, CO2 limits on cars would probably spell the end of large SUVs capable of delivering the car-like performance that has been a key factor in their success.

The case in question hinges on legal interpretations of existing anti-pollution legislation, over whether CO2 and other greenhouse gases constitute pollution that the EPA should regulate, and on the standing of the states to bring suit in this matter. Court-watchers seem to think it will be a close call. If the court finds for the states, the consequences could be far-reaching. It would certainly affect the kind of cars we will drive in the future, and it could even expose the basic process of combustion to product-defect suits. (I can just picture the caveman from Geico's current ads in the docket, defending whether he knew, when he invented fire, that it could harm the planet.)

With regard to the implications for cars in general, and SUVs in particular, the low-cost efficiency technologies cited by the Chronicle have already been deployed, including better fuel injection, and more advanced engines and transmissions. Although all of these have scope for further development, most of the improvements in these areas so far have been employed in the service of better performance, delivering better 0-60 acceleration and passing power, rather than increased fuel economy. As a result, consumers have been able to purchase 6,000 lb. vehicles that drive more or less like sports sedans. That reflects an expensive and sometimes hazardous consumer expectation that moving up to much larger, heavier vehicles entails minimal trade-offs. It ought to be perfectly possible to produce attractive, practical SUVs that deliver substantial fuel savings at a modest increase in sticker price, without resorting to expensive hybridization. What must give, however, is either weight--and thus size--or acceleration.

If consumers were willing to accept 0-60 times over 10 seconds, there's no reason they couldn't buy Tahoes or Expeditions that conform to a future greenhouse gas emissions limit. They just wouldn't be as nimble or fun. That might even reduce the temptation to drive these vehicles beyond the typical driver's ability to react safely to an unexpected hazard or bend in the road, in the process easing the threat that SUVs pose to smaller cars. I'm sure Detroit's design departments will be watching the Supreme Court proceedings closely.

Tuesday, November 28, 2006

My holiday schedule precluded addressing The Economist's cover story on alternative energy when it came out last week, but I still feel obliged to comment on several of its points. The title reveals the article's conclusions: "Green Dreams, The risky boom in the clean-energy business." (Subscription may be required.) While extolling clean energy from a societal perspective, they conclude that it isn't such a good deal for those investing in the companies that make it happen. They are right to point out the serious risks involved, as well as some of the ways that government incentives are distorting the market, but I believe they exaggerate the downside and minimize the upside. We are a long way from a ticking Dot-Bomb, here.

As my regular readers know, I think some skepticism is appropriate, at least with regard to the scale of alternative energy's contribution to the global energy market in the next decade or so. Even at current prices, oil, gas and coal won't be easily dislodged from the dominance they've achieved, and non-hydroelectric alternatives start from a very small base, supplying less than 10 of the roughly 450 quadrillion BTUs the world uses every year. But from an alternative energy investor perspective, that looks like a much bigger opportunity than a problem. It suggests it will be a long time before wind, solar, or biofuels approach market saturation, or start to compete seriously with each other, rather than just with traditional energy.

Take solar as an example. The Economist worries that if photovoltaic module production capacity doubles by 2010, as they indicate Goldman Sachs expects, this could lead to a glut of photovoltaic panels (PV). The International Energy Agency reported total global PV capacity at the end of 2005 at 3700 MW installed, with 2005 additions of just over 1000 MW. But in order for solar additions to continue to grow at the roughly 25% annual rate they've experienced in the last several years--which is presumably built into the current valuations of solar companies--then production capacity must at least double by 2010 to maintain that pace, with extrapolated additions in 2011 calculating out to 2800 MW. Moreover, at that rate by 2010 total cumulative PV capacity would still only be about 12 GW, or less than 3% of projected global electrical generation capacity for that year. Now that's what I call headroom.

If a correction in the alternative energy sector is coming, it is much likelier to flow from the vagaries of government policies, rather than from any lack of market opportunities. The longer countries such as Germany subsidize green power by multiples of the cost of conventional power, the greater the likelihood of an unpleasant surprise, later. Investors should focus on technologies and markets that don't depend on unsustainable subsidies continuing in perpetuity, but neither should they ignore the implicit future value of greenhouse gas emissions reductions, which the article mentions only in passing. And while the rapid changes in clean energy technology increase the risk of backing the wrong horse, that's no different than any other start-up in an immature sector. Ultimately, I'd have thought The Economist's skeptical advice would have been better aimed at governments than investors, who have learned a few things since the 1990s.

Monday, November 27, 2006

Last week, while most Americans were preparing for Thanksgiving, many of the world's leading countries were signing a long-awaited international agreement for an advanced nuclear fusion research program, aimed at producing a commercial fusion reactor within the next half-century. In describing this announcement, the Financial Times cited concerns from environmentalists that the dream of clean (essentially carbon-free, low-radiation) energy from fusion could distract us from the need to address the greenhouse gas emissions from conventional power plants. I suppose I can understand the logic that worries them: climate change is a long-term problem, and fusion is a long-term energy solution, so they might superficially seem well matched. However, that notion doesn't withstand scrutiny, either as a potential advantage of fusion or a drawback of funding this research.

Despite decades of research, we're still a long way from replicating the proton-proton fusion reaction that powers the sun. Fusion researchers have focused on two easier reactions involving heavier forms of hydrogen, the deuterium-deuterium reaction and the deuterium-tritium reaction. The facility formerly known as the International Thermonuclear Experimental Reactor, which still bears the resulting ITER acronym, will employ the latter reaction. While requiring less input energy, it still emits neutrons. So although the radiation from the ITER will be much lower than from a conventional fission power plant, it won't be zero. That will complicate the eventual permitting for any reactor designs that come out of this effort.

Fusion power has always seemed thirty or forty years away, since at least the late 1960s. Producing commercial power from fusion is highly challenging, because it requires solving fundamental problems of science and engineering, not just working the bugs out of existing technology. The nature of these problems makes exact prediction of a breakthrough impossible, as well as rendering the subsequent development timeline highly uncertain. But even if we assume that a commercial fusion plant design will be available by 2045, it might take a further 30-40 years for fusion to displace all coal-fired power plants, and their associated emissions. That's hardly a panacea for global warming.

To make matters worse, climate change involves a high degree of inertia. The carbon dioxide going into the atmosphere today will stay there for a century or more. The recent report from the UK government suggested that atmospheric CO2 concentrations are likely to rise to 550 ppm --double their pre-industrial level--by as early as 2035, without drastic action to mitigate emissions. (While I recently expressed some concerns about the Stern Report's longer-term conclusions, this prediction seems pretty solid.) That means that before nuclear fusion can even become a viable energy option to compete with solar power, wind power, or fission--let alone coal--we will already have emitted enough greenhouse gases to cause serious problems for our great, great grandchildren. In other words, if we're going to solve our climate problem, we must be well on the way before fusion can become practical.

So why bother with it at all? Well, regardless of your views on Peak Oil, fossil fuels are ultimately finite and come with a lot of environmental baggage. While renewable energy sources such as biofuel, wind and solar have tremendous potential, I don't see them replacing the entire energy pie, unless it's a much smaller pie than today's--not just per capita, but in absolute terms. Fusion and space-based solar power constitute our two most promising long-term, large-scale energy options that don't bump into significant constraints from land use, water availability, soil depletion, or aesthetics. Pursuing fusion power ought to be as high a priority as possible, given its very long gestation period and slow progress, irrespective of our concerns about climate change.

Wednesday, November 22, 2006

The feature article in last Sunday's Washington Post Magazine struck me as a perfect pre-Thanksgiving topic. It described an environmentally-based "intentional community" called Earthaven, in the Blue Ridge Mountains of North Carolina. Its members practice a low-energy lifestyle to a degree that few of us would willingly embrace, but which they apparently regard as virtually inevitable, based on current trends of environmental damage and oil depletion. The article serves as a reminder of the degree to which the rest of us treat reliable and plentiful--if no longer cheap--energy as an entitlement. We might reflect on that during Thanksgiving celebrations reflecting our remarkable abundance, in global or historical terms. At the same time, I wonder how healthy it would be to focus on energy and its environmental consequences to the extent that the Earthaven'ers have done.

While I'm not about to give up cars, air conditioners, television, and the other trappings of modern life, I respect those who are willing to live out their convictions about reducing their impact on the planet. As I read the article, though, I found myself tabulating the items in their community that wouldn't be available if the whole country followed this path. Laptop computers and rooftop solar arrays, for example are the fruits of a high-energy civilization, not subsistence farming. Although I wouldn't characterize Earthaven as a survivalist community, I was nevertheless reminded of the post-apocalyptic fiction I used to read, in which the survivors of some global disaster cherish their remaining technological tools, knowing they can never replace them. As the article's author points out, it's just not possible for all the world's inhabitants to live this way. We need large-scale agriculture and large-scale industry to support 6 billion people, on our way to 8 or 9 billion.

As much time as I spend focusing on energy and the environment, I hate to think what would happen if everyone were equally focused on these topics. There's got to be a middle ground between obsession and indifference, though, where Americans can incorporate energy and environmental factors into their decisions, without dwelling on them morbidly. The means of doing this, consistent with our market-based society, is to translate their impacts into transparent financial terms. Give people real-time electricity metering with time-of-day pricing, and let them see how much power that plasma TV or old refrigerator is really using, and how much it costs. Give them tools for identifying and offsetting or reducing their greenhouse gas emissions; TerraPass is a great first step in that direction. Posting lifetime greenhouse gas emissions on new car stickers, alongside the EPA gas mileage estimates, couldn't hurt, either: 20 tons of CO2 in 100,000 miles for a Toyota Prius, 40 tons for an average sedan, and 75 tons for a large SUV.

The Earthaven concept is admirable but unrealistic for most of us. That doesn't preclude a moment of gratitude this Thanksgiving for the electricity or natural gas that roasted the turkey, and the petroleum products that fueled the plane or car that took us to grandmother's house--while remembering the contribution that each of those made to warming the earth. That might sound corny, but even a modest increase in energy and environmental awareness might alter our behavior, which remains the biggest near-term factor in addressing our energy and environmental problems--more than any new technology.

Happy Thanksgiving to my US readers. New postings will resume on Monday.